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Parent PLUS Loans: Putting Your Money to Work for You

So, you are the proud parent of a son or daughter who is enrolled in post-graduate studies (e.g., law or medicine), and he/she has a bright future as a highly skilled practitioner. As a parent, you have reason to be proud. However, you have also chosen to take out a Parent PLUS loan to help your child with his/her education, and high the cost has left you with a substantial debt burden in the form of a Parent PLUS loan. Now, now you need to figure out how to deal with this burden without going bankrupt. You are not alone; in fact, you are part of the fastest-growing population of loan borrowers.

Statistics on Seniors taking out PLUS loans

As you are likely painfully aware, the cost of such education has been skyrocketing in recent years, and it’s not uncommon to accumulate more than $100,000 of student loan debt if your son or daughter is attending a post-graduate institution.

According to a new report from the federal Consumer Financial Protection Bureau, the number of seniors (ages 60 and older) with student loan debt has quadrupled over the last decade to 6.4 percent, and the average amount they owed has also increased to $23,500 from only $12,100 a decade ago. The government watchdog agency reviewed data from 2005 to 2015, and found that people 60 and older owe an estimated $66.7 billion in student loans. And this is in addition to mortgage, credit card, medical and auto-related debt. Nearly three-quarters of senior borrowers said their loans were for a child or grandchild’s higher education, compared with about 27 percent whose debt was for their own or a spouse’s education.

The Wisdom of Parent PLUS Loans

Many financial advisors do not recommend parents taking out student loans for their dependent children, and there is talk in Congress of discontinuing Parent PLUS loans altogether. After all, student loans are meant for students, not their parents. Furthermore, many of the repayment & forgiveness programs are directed at the student borrowers, not the parents, hence there are restrictions on the types of relief that are available to parent borrowers. Because of this, experts agree that parents should only borrow what they can fully repay in 10 years or before retirement, whichever comes first.

Direct PLUS loans have a distinctive feature: the award amount is not based on a borrower’s ability to repay. As long as parents have decent credit, there is no limit to the amount a parent borrower can request. As such, there should be no surprise that in 2015, more than 200,000 parents age 65 and older were still repaying PLUS loans. Even if you are retired, the obligation to repay federal student loans does not end. Furthermore, if you default on any or your federal education loans, the federal government may offset up to 15% of your Social Security disability and retirement benefits to repay any defaulted loans.

The timing is not good: for many people, retirement also means a reduction in income. Retirement benefits are intended to cover living expenses, not to make loan payments. And if your child attended a post-graduate program, you may well be saddled with debt in the 6-figure range. Fortunately, it’s not the end of the world; there are ways to relieve this burden.

Putting your Money to Work

There is a well-known saying that basically states: “Most people work for money; smart people put their money to work for them”. By this point in your life, you should have built up a retirement nest egg, probably in the form of an IRA and/or 401(k) plan, as well as investments that are outside your retirement plan. If you are one of these fortunate people, then you can use your savings to offset loan payments. However, it is not a good idea to deplete your life savings to pay off student loans. Instead, you can (and should) put your money to work for you.

The closer you are to retirement, the more conservative your portfolio should be. If you are over age 50, the bulk of your investment portfolio should be allocated toward safer and more stable assets such as bonds and/or dividend-paying blue-chip stocks (versus growth stocks or small capitalization stocks). This means that your portfolio should be generating income in the form of dividends (e.g., blue-chip stocks) or interest (e.g., bonds). The income from these investments can be allocated toward offsetting loan payments without depleting your principal.

The current interest rate on corporate bonds ranges from 3% to 5%, depending upon the bond rating. Certain high dividend-paying blue-chip stocks are also paying dividends in the same range. Actual rates will vary, so consult your investment advisor for accurate dividend payout & interest rates.

Let’s say that your retirement plan consists of income-producing assets (remember that these returns are tax-deferred while they remain inside your retirement plan), and you establish monthly withdrawals from your account. Let’s use an example of a $100,000 loan at 7% interest and a payback period of 10 years. Depending upon the rate of return on investment, the following table illustrates the amount required to offset the monthly payment:

Loan principal: $100,000

Interest: 7%

Standard payback period: 10 years

Monthly loan payment: $1,161

Table: Amount required to generate $1,161 monthly ($13,932 annually):

Furthermore, if you are under the age of 59 & ½ and these funds are used to pay for qualified education expenses, there is no early withdrawal penalty.Hence, if you establish monthly withdrawals from your account in the amount of $1,161, this would fully offset the monthly loan payments without depleting your portfolio.

Coordinating with Tax Benefits

However, there are two additional benefits that your government provides: interest deductions and tax credits. Currently, the amount of interest that could be deducted from your annual income is $2,500. If you are in a 28% marginal tax bracket, this equates to a potential reduction in taxes of $700. Tax credits are much more powerful, because they are a direct reduction in the tax, as opposed to a deduction from income. Currently, you may enjoy a tax credit of $2,000.

When you add these two benefits together, your total tax savings could be as much as $2,700. If you divide this by 12, then your monthly benefit would be approximately $225. If you subtract this amount from the monthly loan payment of $1,161, the result is equal to $936. Hence, your portfolio would only need to generate $11,232 in annual interest or dividends ($939 monthly), versus $13,932. At 5%, this would reduce the required investment principle to $224,640 as opposed to $278,640, a reduction of $54,000.

The example below illustrates the adjusted amount after maximizing the tax benefits:

Loan principal: $100,000

Interest: 7%

Standard payback period: 10 years

Monthly loan payment: $1,161

Adjusted payment: $939

Amount required to generate $936 monthly ($11,232 annually):

There is a caveat to this: depending upon your modified adjusted gross income (MAGI), your interest deduction as well as your tax credit could be phased out. (MAGI for most people is the amount of AGI (adjusted gross income), shown on your tax return. On Form 1040A, AGI is on line 22 and is the same as MAGI.)

The rules for interest deductions and tax credits are as follows:

Lifetime learning credit. For 2017, the amount of your lifetime learning credit is gradually reduced (phased out) if your MAGI is between $56,000 and $66,000 ($112,000 and $132,000 if you file a joint return). You can’t claim the credit if your MAGI is $66,000 or more ($132,000 or more if you file a joint return).

Student loan interest deduction. For 2017, the amount of your student loan interest deduction is gradually reduced (phased out) if your MAGI is between $65,000 and $80,000 ($135,000 and $165,000 if you file a joint return). You can’t claim the deduction if your MAGI is $80,000 or more ($165,000 or more if you file a joint return).

Federal Relief Programs

But you say, “I don’t have that much in my retirement or investment portfolio!” I understand; but any amount that you can use to offset loan payments is better than nothing. Fortunately, there are various plans that you can avail yourself of to help ease the burden. Here are two that you should be aware of: the Income-Contingent Repayment Plan (ICR), and the Extended Repayment Plan (ERP).

It should be noted that, unlike relief programs directed at students, Parent PLUS loans come with certain restrictions that are not available to student borrowers. For example, parents with such loans are not permitted to avail themselves of Income-based Repayment (IBR) or Pay As You Earn Repayment (PAYE) plans.

Income-Contingent Repayment Plan (ICR)

Under this plan, you must first consolidate your loans into a Direct Consolidation Loan. With this plan, your monthly payment will be the lesser of:

20 percent of discretionary income, or

The amount you would pay on a repayment plan with a fixed payment over 12 years, adjusted according to your income

Payments are recalculated each year and are based on your updated income, family size, and the total amount of your Direct Loans. You must update your income and family size each year, even if they haven’t changed. If you’re married, your spouse’s income or loan debt will be considered only if you file a joint tax return or you choose to repay your Direct Loans jointly with your spouse. Any outstanding balance will be forgiven if you haven’t repaid your loan in full after 25 years. However, you must bear in mind that any amount forgiven will be considered taxable income, meaning that you could suddenly find yourself facing a large tax bill.

Caveat: depending upon your income, some ICR plans may result in higher payments! Be sure to consult your loan advisor for particulars.

Extended Repayment Plan (ERP)

Under this plan, you can extend your payments over a longer period of time. To qualify, you must have more than $30,000 in outstanding Direct Loans. Your monthly payments will be lower than under the 10-year Standard Plan, but the total interest paid over the life of the loan is significantly higher.

Payments may be fixed or graduated

Payments will ensure that the loan will be paid off within 25 years

You do not qualify for Public Service Loan Forgiveness (PSLF)

Note that the federal government bases eligibility for these payment plans on reportable discretionary income, family size, and loan amounts. They do NOT take into account whether the borrower has assets in a retirement account or non-retirement investment portfolio. Hence, it may be possible to apply for one of these programs even if you have investable assets. I strongly recommend that you consult an attorney or loan representative to verify whether this is applicable in your case. You can also get help from Student Loan Planner by following this link: https://studentloanplanner.com/hire-student-loan-help/.

Putting it All Together: Coordinating Investments to Maximizing Benefits

Together with your portfolio, the available programs and tax benefits can go a long way toward relieving the burden of your Parent PLUS loan.

Let’s use the $100,000 loan example, this time with a payback period of 25 years.

Loan principal: $100,000

Interest: 7%

Payback period: 25 years

Monthly loan payment: $706

Amount required to generate $706 monthly ($8,472 annually):

This is starting to look much better. But what about taking into consideration the tax deduction and tax credit? In this case, the monthly adjusted payment could even be lower!

The table below shows the amounts required to generate the adjusted payment:

Loan principal: $100,000

Interest: 7%

Payback period: 25 years

Monthly loan payment: $706

Adjusted payment: $481

Amount required to generate $481 monthly ($5,772 annually):

No matter what you have available in your portfolio, the key point is to preserve your assets and put your money to work offsetting loan payments. Obviously, if you can pay back the loan sooner, you will save substantially in total interest (and anxiety). Furthermore, if you can available yourself of the various relief and tax benefits, you will likely be better off in the long run. And congratulations on your child’s education!